If you find both terms confusing, don’t worry you are not alone, and yes, these terms are confusing.
Accounts payable and accounts receivable are two very similar in the way we tend to record them however, mixing both terms will make you lose precious time and could even ruin your financial statement.
To start, here is a quick definition:
- Accounts payable: this account represents your company’s obligation to pay off short-term debts to your creditors or suppliers.
- Accounts receivable: this account represents all the transactions yet to be paid by your customers or partners.
Accounts payable = Liability Accounts Receivable = Current Asset
Let’s see a practical example:
A. In most cases, companies will negotiate their payment terms to best suit their needs. This enables the company to purchase what is necessary for them at credit, make a profit and then pay off their debts. But when a company buys 25 different things from 25 different suppliers, the company needs to keep a record of all these debts. That’s where accounts payable comes into action.
This way, the company knows when to repay, to whom and how much.
B. A company using accounts payable to keep a record of their debts also needs an account to keep a record of what they owe. For example, a shoe manufacturing company might require 10 to 20 different suppliers in order to create its products (hence, using accounts payable) but then it becomes the supplier, selling shoes, at credit, to stores. That’s where the accounts receivable is required.
This way, you know who owes you, how much and when you should expect to be paid.
At this stage, you might already get the picture. Implementing these two accounts in your company isn’t a need, it is vital. And let’s be honest, whether you are starting a business or are managing an entire finance department, correctly applying these two concepts is a challenge.
“even industry leaders are sometimes failing to achieve it”
Finally, mistakes you should avoid at all costs:
In general, we tend to manage better ways the money that others owe us, than the opposite. That’s not to say that it less important but it is a “natural” way of thinking.
3 Accounts payable common mistakes:
1. Poor data entry: this might sound silly but about 70% of companies out there are struggling at this essential stage. If you are still using spreadsheets to record information, chances are that you are part of this group.
“88% of Excel spreadsheets used by businesses contain significant errors”
2. Duplicate payments: no one wants to pay twice for one product or service and yet this mistake is one of the most common ones in accounts payable. Make sure you can tell when an invoice has been paid, set up a reconciliation report or take the time to double check every invoice. Don’t expect your vendor to tell you it’s been paid twice, especially if he is also struggling with his accounts. Truth is he might not even be aware of it!
3. Rely on manual processes: given the complexity of the task, relying on manual processes is the same as shooting yourself in the foot. You will loose time, money and mental health. Depending on your company’s size, the necessity of automating processes could range from ‘required’ to ‘vital’ but one thing is sure, at some stage, you will need a more reliable system than excel spreadsheets and emails. Just bear in mind that processing invoices manually costs on average ~$20 against ~$3 once automated.
3 Accounts Receivable common mistakes:
1. Skipping the due diligence part: would you lend money to a complete stranger? No, right? The same logic applies between companies. Too many businesses overlook their customer’s credit profile which results in over-extended credit limits and additional stress for your accountants.
2. Not sending reminders: whether it is because you have too much work or because you did not check your overdue invoices, not sending reminders could make your debtors think that it is not a priority when it is. Don’t let them think that you have forgotten the debt because you will be considered as less important than other suppliers.
3. Not offering online payments: the more options you give to your customers to pay you back, the easier it is for you to see your money flowing back into your accounts. Online payments are a good way to provide your customers access to their invoices so that they can pay online. It might require you to update your software, but it will make you and your team’s life easier.
In all cases, a good methodology and reliable software are key to avoid the many mistakes surrounding accounts payable and accounts receivable. Unfortunately, many companies focus their attention on the more “glamorous” departments such as sales or marketing, but the reality is that these companies are losing money by not applying invoice processing best practices.
So, if you have read this article until this point, chances are that you are looking to turn the spotlight on your finance department. In that case, we can only advise you to assess your actual capabilities and if you are part of the many companies that still use manual invoices, switch to automated processes.